Is blockchain the missing piece to financial inclusion? - in collaboration with - Oradian
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Is blockchain the missing
piece to financial inclusion?
in collaboration withContents
1. The financial inclusion business model 4
2. Operational pain points for frontier market MFIs 4
- Issues in client capture 4
- Issues in linking customers’ bank accounts to MFI services 5
- Operational inefficiencies 5
- Technology limitations 5
3. Decoding blockchain 5
4. The benefits of blockchain 7
- Trust by design 7
- Auditability 7
- Efficiency 7
- Low costs 7
- Smart Contracts 6
I. Key application of blockchain in financial inclusion 8
- Digital identity management 8
- Instant and cost-efficient remittances 8
- Alternative credit scoring 8
- Prevention of fraud 8
5. Current state and outlook of blockchain application in
financial inclusion 9
I. Hurdles in mainstream adoption of a blockchain network for MFIs 9
- Current infrastructure of MFIs 9
- Interoperability 9
- Privacy 9
- Regulatory compliance 9
II. Recommendations 9
- For governments and regulators in frontier markets 10
- For the formal financial services industry 10
- For MFIs and rural banks in frontier markets 10
III. Outlook 114
Is blockchain the missing piece to financial inclusion?
1. The financial inclusion business model
The World Bank estimates that over two billion adults worldwide don’t have a basic bank account (1),
excluding them from the financial tools they need to facilitate in everyday life, to guard against risk,
and to invest in their futures. Microfinance institutions (MFIs) in the frontier markets of Africa, Asia
and Latin America play an invaluable role in driving financial inclusion among this unbanked and
underbanked population.
Though their business model has proven to be sustainable and effective in promoting financial
inclusion, MFIs face a range of challenges around customer identification, technology infrastructure,
fraud and operating costs. This paper considers the potential role of blockchain in addressing these
challenges, as well as the barriers to widespread adoption of blockchain among frontier market MFIs.
Unbanked population in 25 countries, predominantly in Asia and Africa
Pakistan Bangladesh Nigeria
India 5.2% 3.7% 2.7%
20.6%
(of the world unbanked) Mexico Egypt Brazil
2.6% 2.4% 2.4%
Turkey Colombia
Vietnam Philippines 1.1% 1.1%
2.4% 2.2%
China Indonesia Ethiopia 2.1%
Tanzania
0.8%
Peru
0.8%
11.6% 5.6%
Myanmar DRC
Morocco
0.7%
South Africa
0.5%
1.5% 1.5% C M K Z R
International Development Association (IDA) countries C: Cote d’Ivoire 0.4% M: Mozambique 0.4%
K: Kenya 0.3% Z: Zambia 0.2% R: Rwanda 0.2%
% Access 0-25% 26-50% 51-100%
Source: World Bank Group
2. Operational pain points for frontier market MFIs
To gain insight into MFIs’ pain points and their perceptions of the blockchain, IBS Intelligence
interviewed an MFI in Asia, a European non-profit organisation that supports African MFIs, and a
fintech company working with frontier market MFIs. Some of the key MFI challenges we identified
through these interviews and our desk research are as follows:
Issues in client capture:
Lack of legal status and identity management structure
Limited collateral offered as guarantee and issues in legal documents attached to the collateral
Improper customer on-boarding techniques i.e. Know Your Customer
Lack of knowledge about MFI services
1.“Financial Inclusion Overview”, World Bank, retrieved April 1 2018.
http://www.worldbank.org/en/topic/financialinclusion/overview5
Is blockchain the missing piece to financial inclusion?
Current model for MFIs to solve financial inclusion
BUSINESS CHANNELS
NGOs
Community based
Facilitators organisations
Co-op societies MFI OFFERINGS
MICROFINANCE TARGET GROUPS
INSTITUTION Village councils
Micro-credit
Self-help groups
Help MFIs in extending reach, Support Micro-insurance
customer screening, education, Joint liability
groups
customer origination & post sale
follow-ups Micro-savings
Individual banking
Grocery stores / Micro-payments/
Petrol pumps remittances
Correspondents
Post offices
Bank on wheels
NGO MFIs
Operate as Point of Sale,
disbursements, receipt and delivery of
remittances / payments
PROCESS
Phase 1 Phase 2 Phase 3 Phase 4
Loan application; Credit Fund approval; Loan e-wallet; Loan Loan closure, Future loan
check; Origination disbursement monitoring; Settlements capture
Source: IBS Intelligence
Operational inefficiencies
Manual data capture by field officers during client meetings
High rates of fraud and human error in business processes
Lag between collecting loan repayments and calculating Portfolio at Risk (PAR)
Lack of real-time reporting across branches
Technology limitations
Legacy core banking systems, or even a complete absence of automated systems
High cost of growing branch networks due to purchasing and implementing on-premise systems
Lack of technical skills to keep up to date with evolution of technology
Blockchain is one of the emerging technologies that may—in the long term—help to address some
of these challenges.
3. Decoding blockchain
Best known as the technology powering cryptocurrencies such as bitcoin, the blockchain is a
decentralised ledger that is used to securely store data, transactions and contracts. Its characteristics
are as follows:6
Is blockchain the missing piece to financial inclusion?
It is shared across multiple computers and updated in real time. Think of the blockchain as a
digital ledger shared between multiple people and companies across numerous Internet-connected
computers. When two parties complete a transaction—for example, Bob agrees to give a bitcoin to
Alice—everyone’s copy of the ledger is automatically updated in real-time to show that Alice is the
owner of a bitcoin, acquired from Bob.
It provides a complete, time-stamped and unalterable record of transactions. Once a transaction
is completed, there will always be a permanent, timestamped record in the ledger. If Bob changes
his mind, he cannot simply delete the record. He also can’t reverse the transaction, without Alice
agreeing to send the bitcoin back to him in a new transaction.
It uses cryptography to ensure the security and integrity of transactions. Cryptography is about
using mathematics to encrypt and decrypt data, so that only the intended recipient can read it. When
Bob is sending a bitcoin to Alice, he will use his private key—a long string of numbers and letters—to
authenticate (or ‘sign’) the transaction. He will send the bitcoin to Alice’s public key, a shorter string
of numbers derived from her private key. Blockchain uses a complicated mathematical algorithm to
generate the public keys, meaning that it is practically impossible to work out a private key from the
public key.
In a public blockchain, such as Bitcoin, anyone may take part in the network and maintain the shared
ledger. All transactions added to the blockchain are public, so anyone can see them. That means it’s
difficult for Bob to dispute that he gave a Bitcoin to Jane—the evidence is there for anyone to see on
the public ledger.
ENCRYPTION VALIDATION DISTRIBUTION
Transaction Transaction
generation completion
Elements of blockchain Impact on transaction
Decentralisation Digital structure Lower costs Faster processing
Data integrity Digital ledger Better security
Source: World Bank Group7
Is blockchain the missing piece to financial inclusion?
Private permissioned blockchains allow a single party or a consortium to set the participation rules
and restrictions for the blockchain. Participants need permission to join. This model is likely to be
more appealing than a public blockchain network for financial institutions like banks and MFIs—it
provides for a higher level of data and transaction privacy.
4. The benefits of blockchain
Blockchain’s inherent advantages may help address some of the key challenges that MFIs face as
they seek to drive financial inclusion and enhance operational efficiencies. However, the financial
inclusion and microfinance sector faces considerable challenges in implementing the technology on
a large scale and in transitioning from an analogue or legacy world to a world of digital trust.
Trust by design
Blockchain provides a way for participants in a business network to continuously store, amend
and share verified data in a transparent manner. More than one party needs to verify each set of
transactions before a block can be added to the chain. Thus, participants in the blockchain can put
their trust in the verification process, even if they do not know each other.
Auditability
The blockchain provides a traceable, timestamped trail of transactions between the participants in
the chain that cannot be deleted or changed. This feature of blockchain could especially be useful in
the MFI model to prevent fraudulent and duplicate transactions.
Efficiency
The decentralised nature of blockchain, with immediate validation of every transaction, allows
for real-time data entry to the digital database without verification by an intermediary such as a
clearing house or payments gateway. This can speed up and streamline the processing of financial
transactions.
Low costs
Blockchain enables low-cost, peer-to-peer transactions, offering an alternative to expensive and
potentially inflexible centralised solutions, infrastructure and authorities.
Smart contracts
‘Smart contracts’ extend the functionality of the blockchain by allowing transactions to be settled
automatically when certain conditions are met. Rather than enforcing the terms of a legal relationship
by means of the courts and the law, a smart contract uses computer code to implement the agreement.
The terms will be set by the parties that control the blockchain.
As a simple example, the French insurer, AXA, is piloting insurance powered by a smart contract.
When someone buys flight delay insurance, the transaction is recorded in the Ethereum blockchain.
This smart contract is connected to global air traffic databases. If the flight for which the person
purchased insurance is delayed by more than two hours, the system automatically pays them
compensation without them needing to make a claim(2).
2.“AXA Goes Blockchain with Fizzy,” AXA, September 13, 2017.
https://www.axa.com/en/newsroom/news/axa-goes-blockchain-with-fizzy8
Is blockchain the missing piece to financial inclusion?
I. Key application of blockchain in financial inclusion
Digital Identity management
Around 1.1 billion people around the world live without an officially recognised identity, according
to the ID2020 project(3). Blockchain technology offers a tamper-proof mechanism to create digital
identities for poor citizens who lack formal identification documentation. Technology firms and
governments are exploring options such as using biometrics to create such a digital identity.
One example is BanQu, an economic identity technology platform that creates a digital profile using
various records of personal, financial and other activities. BanQu enables the unbanked to develop a
tractable, vetted financial and personal history as they transact on the BanQu blockchain. While this
platform is currently being used to create a record for refugees, financial institutions could use the
platform to track unbanked and underbanked citizens(4).
Alternative credit scoring
World Bank statistics show that public credit databases in many emerging market countries cover
less than 10% of the population(5).
If the microfinance sector in a country or region cooperated on a shared blockchain platform, it could
build a decentralised alternative to the formal credit bureaus. Borrowers’ transactional history could
be recorded on a shared ledger, giving credit officers insight into their borrowing and repayment
histories, as well as the outstanding loans in their name.
Prevention of fraud
MFIs face a constant risk of fraud and excessive borrowing by a single individual, which often results
in losses and bad debts. Once all MFIs and banks are able to aggregate their customer data in a
blockchain network, instances of individuals borrowing excessively from multiple lenders or multiple
borrowers pledging the same collateral could be prevented.
5. Current state and outlook of blockchain application in financial
inclusion
Recent proof of concept projects and small-scale applications show that blockchain has significant
potential as a tool for improving financial inclusion. However, there are numerous barriers to
mainstream adoption of blockchain technology.
3.“An Alliance Committed to Improving Lives through Digital Identity”, ID2020, retrieved April 1l 2018.
https://id2020.org/
4.Banqu, retrieved April 1 2018.
www.banquapp.com
5.“World Bank, Doing Business Project”, World Bank, retrieved April 1, 2018.
https://data.worldbank.org/indicator/IC.CRD.PUBL.ZS9
Is blockchain the missing piece to financial inclusion?
I. Hurdles in mainstream adoption of a blockchain network for MFIs
Current infrastructure of MFIs
MFIs in countries such as India and Bangladesh have put in place core banking and lending solutions
with functionality that is comparable to mainstream banking software. However, MFIs in many parts
of Africa and Asia still use spreadsheets or even pen and paper to record their transactional data.
This lack of basic technology infrastructure will hold them back from adopting blockchain-based
solutions, which rely on digital data as a fundamental requirement.
Interoperability
In an ideal world, blockchain technology will allow multiple users and organisations to share
information and transact without any cross-border limitations. But with numerous organisations
worldwide working to create their own blockchain platforms, interoperability and fragmentation may
become barriers to adoption.
Privacy
Blockchain represents a potential shift away from a traditional, centralised model where users’ data
and transactions are stored in secure, private databases. A public blockchain or even a private
blockchain serving a large community of organisations and people may bring a level of transparency
to private information that some people may find uncomfortable.
Regulatory compliance
Regulators in many countries—tasked with ensuring stability and fairness in the financial system—are
wary of the blockchain. There are many complex compliance issues for them to consider, including
which country has jurisdiction across borders and who takes liability since as blockchains are not
locked to a specific location or controlled by a single party. Since transactions are instant and cannot
be modified, regulators may also be concerned about how errors or fraudulent transactions can be
amended.
II. Recommendations
The blockchain could play a valuable role in the delivery of financial services to the financially
excluded in the future. In the shorter term, however, the technology is not mature enough to address
the challenges MFIs experience in enhancing operational efficiency, reducing bad debt and losses,
making better credit decisions or cutting fraud.
In the longer term, Oradian and IBS believe blockchain will be a useful back-end technology that will
help MFIs to streamline their interactions with the wider financial ecosystem. We do not envisage that
it will have a direct impact in end-consumers’ experience with the MFI any time soon. Based on our
research, our recommendations are as follows:
For governments and regulators in frontier markets
Start putting in place legal and regulatory frameworks that encourage the financial services industry
and fintech companies to experiment and innovate with blockchain.10
Is blockchain the missing piece to financial inclusion?
Monitor the progress of projects such as ‘ID2020’— an alliance of UN agencies, NGOs, governments,
and enterprises committed to improving lives through digital identity—and participate if appropriate.
Such programmes and projects could help to address financial inclusion challenges and challenges
of interoperability at great scale.
For the formal financial services industry
The mainstream deployment of this technology will depend on a concerted effort by banks, financial
institutions and fintech firms. The immediately realisable benefit is the ability to create a digital
identity and record customer data on a shared immutable database accessible to all regulated
financial institutions and governments. Institutions should be open to working with fintech firms
specialised in blockchain applications to develop solutions that benefit the entire industry.
For MFIs and rural banks in frontier markets
The priority for MFIs shouldn’t be ‘how’ and ‘when’ to use the blockchain, but to put in place
technology platforms that enable them to digitise their operational data, streamline transactions
and gain more visibility into customers and transactions. This will deliver dramatic improvements to
their business performance in the short to medium term, while enabling them to prepare for a future
where blockchain is ready for mainstream use.
III. Outlook
When deployed on a wide scale, the blockchain could offer rich and exciting applications for MFIs.
Smart contracts could enable MFIs to automate many processes that are performed manually today—
for example, authorising a loan after verifying a user’s economic identity. The blockchain could
also provide data for analytics, which could be used with machine learning algorithms or artificial
intelligence to optimise loan amounts, terms, and interest rates, assess creditworthiness of unbanked
customers, or identify fraudulent transactions.
However, blockchain still faces a range of technical, regulatory and practical challenges. It will take
years of careful coordination and collaboration between global stakeholders to solve these challenges
and prepare the blockchain for widespread use in the financial inclusion sector. Until then, the
focus for MFIs should be on using technology that enables them to get the basics right: simpler
administration, knowing their portfolio and serving more clients.11
Is blockchain the missing piece to financial inclusion?
About Oradian
Oradian is a financial inclusion company serving financial institutions in remote, hard-to-reach
communities. Using insights from their community of customers, Oradian builds a cloud-based
toolset that smart financial institutions plug into to know and control their portfolios.
Oradian’s toolset enables financial institutions to become more efficient, grow and serve more
clients. Oradian provides access to its toolset on a subscription basis, making it possible for financial
institutions to access leading technology.
Today, Oradian’s community is made up of more than 65 financial institutions in eight countries
with a concentration in the Philippines and Nigeria. Collectively, Oradian’s community of financial
institutions provides access to financial services for over two million end-clients throughout Southeast
Asia, West Africa and East Africa.
Contact us
www.oradian.com hello@oradian.com www.facebook.com/oradian
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